Junior bondholders in Dublin-based Allied Irish Banks Plc
will decide this week on an offer to buy back more than $5
billion of subordinated debt at 30 percent of face value.
Analysts at BNP Paribas SA recommend investors accept the
package or risk getting “the stick” after the government
passed laws allowing it to reduce payments to bondholders.

“The draconian powers granted to the Irish finance
minister in December are a game-changer for subordinated
bondholders in Irish banks,” said Ivan Zubo, a London-based
credit analyst at BNP Paribas. “Clearly, there is a risk that
the more drastic powers could be used if Allied Irish needs more
capital in the future.”

Costs to insure the subordinated debt of Allied Irish, the
country’s second-biggest bank, was 63.5 percent upfront and 5
percent a year as of Jan. 14, meaning it cost 6.35 million euros
($8.5 million) in advance and 500,000 euros annually to protect
10 million euros of debt for five years, CMA prices in London
show. That compares with 21.7 percent upfront three months ago.

Ireland is taking control of Allied Irish, making it the
fourth lender seized by the state as bad debts threaten to
topple the country’s financial system. Lenihan said on Jan. 12
in parliament that after Allied Irish bondholders take
“whatever pain is inflicted upon them,” it will have a
“material bearing” on the cost of saving the bank.

Crisis Resolution

European leaders and regulators worldwide are considering
steps that would force bondholders to share a larger proportion
of costs from any future banking bailouts. European Union
leaders agreed last month to set up a permanent crisis
resolution system to start in 2013.

After German Chancellor Angela Merkel called on bondholders
to share the burden, the European Commission proposed Jan. 6
that bank regulators be allowed to write down senior debt before
relying on the taxpayer to save a failing lender.

Senior bondholders aren’t currently at risk, including
those holding Irish debt.

“The debate has definitely changed,” said Hank Calenti, a
credit analyst at Societe Generale SA in London. “It used to be
about whether the subordinated bondholders would have to pay;
now it’s about whether the seniors will be hit.”

Yield Spread

The extra yield investors demand to hold Irish 10-year
bonds rather than German securities of similar maturity has
narrowed to 578 basis points from a euro-era record of 680
points on Nov. 30, two days after the scale of bank losses
forced Ireland to accept an international bailout. The spread
over German debt is still more than nine times the average of
the past decade, Bloomberg data show.

The Irish rescue package agreed with the EU and the
International Monetary Fund includes as much as 35 billion euros
of aid for the banks. Central Bank Governor Patrick Honohan said
before the bailout was inked that total loan losses at the
country’s lenders, including foreign-owned banks, total at least
85 billion euros.

The government is taking a 92.8 percent stake in Allied
Irish after injecting 3.7 billion euros into the lender last
month. The state already took control of Anglo Irish Bank Corp.,
Irish Nationwide Building Society and EBS Building Society.

‘Enforce Losses’

Ireland introduced laws last month allowing it to force
junior bank bondholders to share losses. The new legislation
allows Lenihan to issue orders to change interest and principal
payments to bondholders and suspend their rights to payment.

The Irish government “has shown its willingness to enforce
losses,” Alexander Plenk, a Munich-based analyst at UniCredit
SpA said in a Jan. 14 note to clients, urging debt holders to
accept Allied Irish’s offer. “We recommend accepting the offer,
as a second offer will be made under worse conditions.”

The central bank will review the banks’ capital again in
March. That process may result in more loan-related losses and
encourage the state to compel junior bondholders to take
additional hits, according to Ciaran Callaghan, an analyst at
NCB Stockbrokers in Dublin.

Anglo Irish, nationalized in 2009, offered in October to
pay bondholders who refused to swap their securities 1 cent per
1,000-euro on the face amount of their subordinated notes. More
than 90 percent of the bondholders of the notes due 2014 and
2016 agreed to swap 766.5 million euros in notes at an 80
percent discount, the Dublin-based bank said last month.

Fitch Ratings said Jan. 13 that Allied Irish’s buyback
isn’t “coercive.” However, if not enough investors accept the
offer, “there will be a higher likelihood that a coercive debt
exchange will take place or losses will be forced onto
subordinated debt holders by other legislative means,” the
rating company said.

“The authorities are holding a big stick,” said Calenti.
“It’s not as onerous as the Anglo stick, but it’s just as
threatening. If you don’t take part in the buyback, you’re
probably not going to get a whole lot more.”